Saturday 24 September 2016

My talk on how the Council Tax system can easily be tweaked to be much like Land Value Tax

Here's my summary of a fifteen-minute talk I did last weekend, I think that some people understood it, or at least understood that I understood it.

What annoys me is that the the Homeys have a favourite KLN that it would require an army of expensive and intrusive surveyors but that the LVTers don't have a proper plan on how it could work on a tedious administrative level to shut them up.

To cut a long story short, all we need to do is set Band D Council Tax in each area as a fixed proportion of the site premium/land value of a Band D home in that area, instead of it being about £1,200, +/- £200 everywhere in the country. So on Day One of the new system, Band D Council Tax would be close to £nil in the very cheapest areas, about £1,400 in median areas, rising to £10,000s in central London. The rest falls into place.

Each of the steps is quite simple in itself, but you have to grasp them all to see how they fit together...

1. There is a fairly fixed relationship between selling prices, gross rental values and site premiums

The three concepts are quite different, but we all know what selling prices and gross rental values are, and selling prices are actually just a multiple of rents. On the whole the multiple is about twenty, which means that gross rental yields are about 5%. This multiple is lower in low rent areas and higher in high rent areas, which exaggerates the differences in selling prices, but hey.

However you calculate the site premium, it is a certain fraction of gross rental values, lower in low rent areas (maybe one-quarter or less) and higher in high rent areas (maybe three-quarters or more). The median is about half and the average for total UK site premium divided by total UK gross rental values (skewed by the top end) is about three-fifths.

Clearly, site premiums at the very lowest end are zero, if you do the numbers, the differences in selling price multiple of gross rents and the site premium as fraction of gross rents largely cancel out and you end with with site premium = +/- 3% of current selling prices. This percentage tapers away to 0% at the very lowest end, of course, where site premium is £nil.

Suffice to say, there are different ways of calculating the Site Premium, this is the least of our worries. Selling prices would be flattened by higher LVT, so can only be used as an indirect check on whether assessed values are about right in future.

2. In any smaller area, there is a fairly fixed relationship between the values of different sized homes

It does not matter whether you are looking at cheap or expensive areas; in most areas, the selling price of gross rental value of a one-bed flat is around 60% of the basic unit of housing, which is a 3-bed semi in the same area; a terraced house is 85% as much and a detached house is 154% as much. The ratio between gross rents is much the same. Therefore we can safely assume that the ratio between site premiums is much the same.

3. How Council Tax works

See Wiki.

To give an example and cut a long story short, a small local council has a spending budget of £100 million and receives grants from central government (out of income tax, NIC, VAT etc) of £76 million. So it needs to raise £24 million in Council Tax.

Homes were originally banded by selling prices in 1991, at the time prices were fairly flat across most of the country, so most one-bed flats ended up in Band A, most 3-bed semi detached homes in Band C or Band D, all the way up to the biggest and most expensive detached houses in Band H.

Council Tax in Band A is 6/9 of whatever it is in Band D and so on, up to the largest homes in Band H where the Council Tax is 18/9 as much.

The council adds up the total number of Band D equivalent homes, so a Band A home counts as 6/9 of a Band D home, a home in Band H is 2 etc.etc,

The council then simply divides required revenues of £24 million by the number of Band D Equivalent homes. If there are 20,000 Band D equivalent homes in that council area, the Council Tax for a Band D home is £1,200.

Having calculated that, the tax in the other Bands follows automatically, Band A is 6/9 x £1,200 = £800 and so on up to Band H where it is £2,400.

Note - Council Tax is thus a highly arbitrary amount, it is a balancing figure between two arbitrarily decided numbers divided by an arbitrary number, LVT can't possibly be worse than this.

4. Put the first three together, and hey presto, Council Tax is in fact a low level LVT

Let's take the same local council, and assume the annual site premium on a 3-bed semi in Band D is £5,000.
3-bed semi's are in Band D, costing £1,200 = 24% of their site premium.
One-bed flats are in Band A, costing £800 on a site premium of about £3,000 = 27% of their site premium.
Terraced houses are in Band C, costing £1,066 on a site premium of about £4,250 = 25% of their site premium.
The largest detached houses in Band H cost £2,400 on a site premium of maybe £10,000 = 24% of the site premium.

That is a fairly flat tax (always something to be welcomed) - but only if you compare the tax bills within a small area. Across the country, the tax rate is hugely regressive, with an effective rate of 30% or 40% in the cheapest areas and 3% or 4% in the most expensive.

So people at the top end are paying nowhere near enough in annual Council Tax (quasi-LVT) but are paying far too much in the 'progressive', transaction and one-off taxes on housing (and private wealth), i.e. Stamp Duty Land Tax, Inheritance Tax, the ATED charge and other assorted nasties.

These all raise surprisingly little money (half as much again as humble old Council Tax) while causing huge amounts of grief to the few paying it and generating loads of work for the pinstriped professionals who leech off the already wealthy at no overall benefit to the economy.

In the spirit of fairness and neutrality, let's assume that our LVT replaces regressive Council Tax and progressive SDLT, IHT, ATED etc. That gives us target revenues of £36 bn a year.

5. Sorting homes/plots by size instead of value

It would be easy to sort homes/plots into bands by absolute size rather than 1991 values. So one-bed flats go into Band A, two-beds into Band B, terraced houses into Band C etc. all the way up to the largest detached homes into Band H. That can be done quickly and cheaply by looking at OS maps, walking up and down the streets and looking at them, seeing what kind of homes they were originally (ignoring extensions etc), how wide the frontage is (far more important that how long the back garden is). Each council can develop its own guidelines and rules of thumb, it's doesn't really matter as long as they are consistently applied.

This will be a lot easier and less contentious than the original Council Tax valuations, which were relatively uncontentious themselves. If we just did this and left Council Tax as is, most bills would not change. That is the beauty of maths, maybe in some areas everybody would go up a band; this increases the number of Band D equivalent homes, so the Band D tax falls accordingly.

This is a one-off exercise and does not need to be repeated for the system to work.

6. Dividing each council up into smaller valuation areas

In most councils, there is quite a discrepancy in values between the cheapest and the most expensive areas, so they would have to be divided up into smaller areas where values are similar. My preferred option is postcode sectors, with about 3,000 homes in each, this size is small enough for there to be little variation but large enough for decent sample sizes on selling prices and market rents.

With a bit of interpolation and sampling, it is a doddle to find out what the site premium of a 3-bed semi, i.e. a Band D home in each valuation area is.

The find the total tax base, we multiply up the site premium of a Band D home by the number of Band D equivalent homes in each smaller valuation area - exactly the same as under the current system - add 'em up to local council level, and then add those up to national level.

We end up with a total site premium for the whole of the UK of anywhere up to £200 bn, but let's call is £150 bn for tactical reasons.

This tells us that the tax rate would have to be 24% of site premiums, 24% x £150 bn = £36 bn, required revenues from 4. above.

The Band D site premium in an area x 24% is then the Band D tax in that area, and the tax bills in all other bands in that area follow automatically - exactly as happens now, see 2. above. Using my worked example in 4. above, tax bills in that council would barely change.

I see no reason why there has to be any great justification of why Band D tax is what is under this system any more than there is under the current system. There is no logic to SDLT or IHT rates and exemptions either.  It is just a tax you have to pay for choosing to own a home with at least some economic justification rather than being completely arbitrary bundle of different overlapping taxes as at present.

7. But Council Tax is a local tax to pay for local services!

… or so people believe, let them believe it if they want to, it is all smoke and mirrors anyway.

In the examples so far, central government will lose £12 bn in revenues from IHT, SDLT etc, so it can simply reduce total grants to those councils where people are now no longer paying so much SDLT, IHT etc. Central government breaks even.

So if our example local council above has lots of high value areas and a total tax base of £125 million, it will be expected to collect £125 million x 24% = £30 million in revised Council Tax, its budgeted spending is still £100 million so its grant from central government is reduced from £76 million to £70 million, Band D tax on average across the council will be £1,500* instead of £1,200 and so on and so forth.

* Clearly, in the cheapest areas within that larger local council area, the Band D tax will be about £1,000 and in the most expensive it will be about £2,000. So the tax on a one-bed flat in a cheap area will be £666 and on the largest detached homes in the most expensive areas it will be £4,000. Which puts paid to the nonsense that some people will be uprooted from their friends and family and forced into ghettoes, you will only have to move a couple of miles to cut your tax bill by 80%, so your previous friends and family will still be in easy reach - perhaps they will even move with you.

At the very bottom, there might be a few local councils where Council Tax will go down and their grants will increase and at the very top, there might be a few councils who are expected to collect more in Council Tax than their actual spending budget, this can all be sorted out and will all net off, let's not get bogged down in the bookkeeping between government departments.

8. Having got the ball rolling, we just keep going

Each year…
a) National taxes (income tax, NIC, VAT etc) are reduced a bit (or a lot),
b) This gives us higher targeted Council Tax/LVT receipts and lower central government grants to higher value areas,
c) Site premium valuations in each area are re-assessed, indexed up, recalculated, whatever,
d) These are totted up to give us the total tax base for the whole country
e) Divide b) by d) to get your new tax rate in %, that sets Band D tax in each area, the council enters that into its master list and everything else falls into place.


benj said...

I think the clearest way of illustrating this was your submission for the Scottish Local Tax Commission, from which you produced a table comparing the liabilities for every band within each Council.

Page 15.

I think the main point is than for a tax to be distortionary, it must be a % of income, capital or transactions.

Although Council Tax is a % selling prices that includes both land and capital, because it is fixed into bands it acts as a lump sum tax, attached to a title deed.

It's incidence it therefore only on land(location) values.

It's problem, that you address with your proposal, it that the amount of land rent it collects from each title owner is very "regressive". That is, the lower the selling price of the property, the high in proportion the "LVT".

Your proposal just flattens that out.

It may not do so as perfectly as a theoretical 100% LVT, 100% of the time (which is impossible anyway), but it gets us 90% of the way there as efficiently and fuss free as possible.

Our present tax system on a scale of 1-10, gets a 4, your modified Council Tax gets us to a 9. Getting to a 10 is diminishing returns people hundreds of years into the future can wring their hands over.

More importantly, there are two problems with a Citizens Income a modified Council Tax/LVT address.

Firstly it is the best way of funding the £20bn shortfall, without adding to deadweight losses.Indeed it reduces them

Secondly, the "pure" Citizens Income, by withdrawing tax credits, disadvantages a small number of single parent households.

The more that is collected from LVT, the more this problem is can be nullified.

James Higham said...

OK, I did wade through it. How do you get from that point you got to - a roadmap, to actually having it happen?

Mark Wadsworth said...

BJ, ta, it is exactly the same idea that I keep wheeling out, I have to work out the best way to make people understand it.

Single mothers and tax credits are one of those stupid anomalies, it is difficult to transition from there because it shouldn't really be there in the first place.

JH, ta, the answer is as quickly or as gradually as we like, as long as the priced out and tenants realise that they are being had and start voting for a tax shift, however slight, we are heading in the right direction.

Even Osborne realised that Home-Owner-Ism had gone a bit too far when he made SDLT higher for landlords and reduced their interest relief a bit.

Bayard said...

Having read it all through, I can't see that it addresses the point that the lower limit of band H is way below the value of the most expensive houses. Is this because you think that doesn't matter in the grand scheme of things or have I just missed something?

Unknown said...

Great article - I get it, I think!

So if it were introduced gradually and over time - giving people like the dreaded little old ladies and people over-exposed to housing time to unwind their positions or er you know um pass away - would it, as a fundamentally local tax, be able to fund the big national programmes - health, education, welfare, etc?

Mark Wadsworth said...

B, we have that issued with under existing council tax the same as under this improved council tax.

Within any valuation area, big detached houses on large plots are - and will be - paying twice as much as a normal semi, which seems about right to me.

Now, there will be a sprinkling of super big detached houses with 18 bedrooms, off street parking for ten cars and a garden big enough for tennis courts and a pool which by rights should cost three or four or five times as much as a semi, but they will only be paying twice as much.

The obvious thing to do is add a few more bands at the top, but in the grander scheme of things, there are so few such houses that it won't make much difference to overall receipts and I shall file that under "tweaks we can add later on".

SV, yes of course, but while health and education are "national" things, they are still provided locally - every hospital or school has to be somewhere and benefits that area more than other areas.

I think the discussion about whether LVT would raise enough to replace all other taxes a bit irrelevant. My opinion is that it could, but that does not matter. The point is that LVT should replace the most damaging and unfair taxes first, and we'll see how it goes.

Lola said...

Understanding 'tax incidence' is also useful IMHO. All taxes are 'incident' on landlords/rents as 'all profits return to rents'. But most of them are very inefficient in taxing rents and carry huge deadweight costs in the process. LVT hugely simplifies tax collection (lots bureaucrats can be released to find more satisfying wealth creating jobs in private business) and taxes unearned rents directly.
What's not to like?

Lola said...

Have you turned that into a powerpoint?

Lola said...

Another good argument for LVT:
From here:- file:///C:/Users/user/Downloads/The%20Size%20and%20Structure%20of%20the%20UK%20Property%20Market%202013-%20A%20Decade%20of%20Change%20(March%202014)%20Summary%20Report.pdf

"Overseas investors’ holdings have more than doubled with no sign of their appetite waning. They now own a quarter of UK investment property, albeit still some way off their 53% stake in the UK equity market.
Fund managers are the largest overseas investor by type, followed by the Sovereign Wealth Funds whose holdings have increased relatively quickly since the 2005 IPF report. Overseas investors have become even
more dominant in City of London offices, now owning 56% of the invested and owner-occupied stock. They also own a third of the total office stock in the West End and Midtown.

L fairfax said...

I would have thought that LVT would be easier than Council tax as it doesn't take account of home improvements (which of course are a good thing and so should not be taxed).

Mark Wadsworth said...

L, agreed and thanks. There's nothing wrong with foreigners owning stuff in the UK, the problem is rents leaking abroad, that is a resounding negative for any economy.

LF, that is the point, Band D tax in an area would just be whatever it is, entirely independent of your individual home improvements or derelictions and some reflection of the home's site premium generally.

So each house is in a council tax band and each house gets a Council Tax bill based on the normal site premium. What is spiteful about council tax is that if you do a big enough improvement, the house gets bumped up a band - when it next changes ownership.

And this is a damn sight easier than LVT, requires minimal admin and faff and as BJ says, gets us 80% of the way there. Why argue about the last 20%? We can argue about that in a few decades.

Unknown said...

What is spiteful about council tax is that if you do a big enough improvement, the house gets bumped up a band - when it next changes ownership.

e-luk how to play

Mark Wadsworth said...

BTO, there are lots of other stupid things about council tax we can get rid of, like exemptions or discounts for vacant/derelict and discounts for single occupants, although I'd give an automatic single person's discount for the smaller flats in Band A. As I said, permitted owner extensions and improvements would be ignored, we are looking at the plot rather than the building itself.

Physiocrat said...

There may be another way of getting at an LVT-like Council Tax. If you look at web sites like Mouseprice you will find there is a "floor" to rentals, below which there is nothing available. Essentially, they are the areas where people voted for Brexit. Coincidence or what? Any rental above that amount represents site premium.

CT would also need quite a large national component which could be redistributed to local authorities on something like a capitation basis.

There is also a need to deal with the UBR. Nissan and Port Talbot steel get clobbered at the moment, when their buildings are on site values worth bugger-all. It would probably be possible to assess large tracts of the country at a nominal amount of next to nothing so unless there were holdings of several square miles, nothing would be payable. That would be a good quid pro quo for getting rid of the CAP.

Neale said...


You say you are looking at the plot not the building. Land value per plot is however based on permitted use. This is why planning permission triggers a rebanding (unfortunately not until next transfer of ownership - if it actually happens).

I have always viewed LVT as being based on permitted use, as that is what affects the rental value of the plot.

In today's planning regime, I guess there's a lot of permitted use already factored into the land value for a domestic property as it's pretty clear what will and will not get permission.

I think we do need to ensure that this works for subdivision of a large plot where permission likelihood may vary significantly. Perhaps this just gets handled by the fact that you now have 2 assessable properties.

Mark Wadsworth said...

N, it is self referential.

The purist definition is "assuming optimum permitted use".

We can safely assume that most developed to their optimum permitted use at the time they were developed. For 95% of buildings that is still the permitted optimum. So no need to differentiate.

There are some plots in more valuable areas where, if we imagine away the actual buildings, it would make sense to build more/bigger starting from today. But even then, given that a building is already there, it would still make no commercial sense to e.g. knock down a detached house with a rental value of £15k in order to build two semi's with a rental value of £10k each. That extra £5k rental value is not worth having, bearing in mind the cost of demolishing and building new (maybe £200,000 all in).

So that sets quite a high hurdle. it only starts makes sense if the detached home rents for £20k and the two semi's would rent for £15k each - the extra £10k is a fair return on costs of £200k.

Then there are the "large plots" or un- and underdeveloped plots in very valuable areas. There's no single easy answer to this. My view would be that extra planning and hence higher LVT bill does not kick in

- for residential until the next sale so that older people can "remain in their homes".
- for commercial, maybe higher LVT deferred until earlier of actual redevelopment of five years from now.

Given that we can't physically build more than 300,000 new homes a year 1% of stock, there is no point imposing the additional LVT (assuming change of use) on more than 1% of stock at any one time.